Experts still fighting over stimulus

WASHINGTON (CBS.MW) - Top policy economists agreed Wednesday on one thing about a fiscal stimulus plan to help the economy out of the ditch: It must be passed immediately to do any good.

But the economists who have advised Republican and Democratic presidents couldn't agree on anything else at a hearing on the economic outlook at the Joint Economic Committee.

In the meantime, more than two months after the terror attacks and eight months after the economy peaked, a stimulus bill is mired in the deeply divided Senate over fundamental disagreements about exactly what should be stimulated: spending or saving.

Weak demand

At the risk of oversimplifying, the Republicans see the slowdown as a supply-side problem while the Democrats say weak demand is the cause.

The Republican-controlled House has passed a $100 billion stimulus plan, focusing on lowering tax rates and improving cash flow for companies.

"Consumer confidence is the issue. To address confidence, we need to focus on job creation," said Glenn Hubbard, head of the president's Council of Economic Advisers.

The Democratic-controlled Senate Finance Committee passed a $73 billion bill that would focus on boosting the safety net for laid off workers, figuring that the jobless would spend every nickel they get, boosting spending throughout the economy.

"In an economy plagued by slack, extra spending means more business orders, more jobs, and less spare capacity," said Janet Yellen, who had Hubbard's job under President Clinton and also was a Federal Reserve governor.

Neither the Finance Committee bill nor any other can move through the Senate without the support of at least 60 of the 100 senators. The Democrats control the Senate 50-49 with one independent.

Both Hubbard and Yellen agree that the long-term prospects for the economy remain good, with healthy productivity growth barely dented by the extra spending that will be needed on security.

Supply side

Hubbard said the collapse in capital investment in late 2000 and in 2001 has nearly eliminated the capital overhang, which is the difference between the actual amount of capital plant and equipment firms have and how much they think they'll need.

But, just in case, the White House plan provides an "insurance" policy against the downside risk that investment spending won't bounce back, Hubbard said.

Eliminating the corporate alternative income tax, lowering marginal tax rates for small businesses and increasing expensing for capital spending would "translate into an impetus for more investment," Hubbard said.

"Investment incentives work through expected reductions in the future cost of capital and increases in corporate cash flow," Hubbard argued.

Yellen violently disagreed. "Such a policy has almost no short-run stimulus potential: a recession is not the right time to use tax policy to stimulate private saving," she said.

Cutting income and corporate taxes now "strikes me as totally irresponsible," she said, arguing that instead of accelerating the tax cuts passed last spring, the attacks and subsequent slowdown "are a good reason to reconsider them."

If Hubbard is right about the long-run path of productivity, Yellen said, "the U.S. economy does not currently face any serious 'supply-side' or productivity-related problem that necessitates a change in tax policy."

Hubbard's reaction to the Democratic plan was just as derisive, calling many of the spending ideas "disguised special interest subsidies and pork-barrel public works projects."

"Throwing money at the problem does not buy meaningful growth insurance," Hubbard said. Pointing to Japan, Hubbard said "trying to spend one's way to faster growth ... has not worked and will not work."

Sales tax moratorium

Another Democratic economist shares many of Hubbard's and Yellen's misgivings about the current approaches by the two parties.

"I wonder what members of Congress can be thinking" when they discuss tax or spending plans that won't be implemented for months or years, said Alan Blinder, who was vice chairman of the Federal Reserve and a top economic adviser to Clinton.

Blinder said a true stimulus package must deliver most of its benefits immediately and it must be tailored specifically to the slowdown.

Blinder repeated a suggestion he made two months ago in the New York Times to break the deadlock: Enact a temporary reduction in sales taxes, with Congress providing federal funds to replace the state and local government's lost revenues.

Blinder said his idea should appeal to both parties, since it's a tax cut geared to consumers. He said it would be easy to implement and it would have the extra bonus of providing money to the states at exactly the time they are cutting back on spending.

"Ordinary Americans ... understand the sales tax in a way they will never understand the corporate AMT or Medicaid provisions.

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